Some of the provisions of the new health care law (some refer to this as "Obamacare") are already in place, and others are set to take effect at the beginning of 2013. When faced with this new law, dealing with its impact within the parameters of its limited guidance could become a daunting task for business owners and employees alike. And although I could probably do a week long seminar on this topic, I'll attempt to break it down into some important bullet points for our readers.
One of the more pressing issues for many taxpayers is how to deal with one of the new law's principle funding mechanisms - the additional Medicare taxes imposed on individuals making over $200,000 ($250,000 if filing jointly). In addition to the traditional 1.45% Medicare tax on wages that everyone pays (matched by their employers), the law requires, beginning on 1/1/13, these taxpayers pay another .9% of their wages in taxes.
In addition, another 3.8% tax is imposed on their net investment income. Net investment income is generally defined as interest, dividends and capital gains.
The tax and how it may affect you:
Gross income does not include items such as tax exempt bonds, veterans benefits, and excluded gain on the sale of principle residence. However, there are at least 3 situations (among others) that I wish to highlight that may cause individuals to be pushed over the income threshold and become subject to these new taxes unexpectedly:
- Gain on the sale of their principle residence in excess of the allowed $250,000/$500,000 gains
- Lump sum distributions from a retirement plan.
- Conversion of a traditional IRA to a Roth IRA
These amounts, although excluded from the definition of net investment income, are included in the calculation of the new tax.
Many small business owners are structured as S Corporation or Partnerships in which all their income passes through to their individual tax returns. The individual tax return is where they would pay their tax, not at the corporation or partnership level. Problem: by definition "Pass Through Income" such as S Corp or Partnership incomes, are considered investment income and would be subject to the new 3.8% tax. This could be a huge burden on small business owners.
The scheduled increase in tax rates for 1/1/13 - Measured alone, the 3.8% tax increase is substantial enough to be more than just a nuisance. When combined with the sunset of the existing tax rate structure and the automatic increase in rates beginning 1/1/13 for capital gains, the current 15% capital gain rate on interest and some dividends, rates could go to 20% plus 3.8% plus .9% or 24.7% in many cases on the same income. Those living on their fixed income dividends take heed. You may want to take proactive action.
(Side-bar - Medical deductions) - The threshold to claim an itemized deduction for unreimbursed medical costs rises from 7.5% to 10% for tax years beginning after 12/31/12. Those aged 65 or older are exempt from this increase until after 2016.
(Side-bar - Flexible Spending Accounts FSA's) - Effective after 12/31/12, FSA's are limited to a maximum annual contribution of $2,500. Previously, there was no federally mandated limit for annual contributions, although some employer plans imposed limits.
Conclusion - No matter what happens after the elections in November, the compliance with all the new rules, and the strategies to minimize their tax impact is something that should not be ignored. The next few months should be used to get with your tax advisor to address these issues.